All that said, it’s clear that investor appetites have shifted and may continue shifting in 2016. From the big picture view, the
market has seen a gradual shift from
prime class A properties only to a willingness to explore and invest in secondary
and even tertiary markets, as well as class
B assets. That’s ultimately because investors are looking for better returns.

“In the Southeast, we continuouslyheard from institutional investors thatthey were only interested in Atlanta,Raleigh, Charlotte and prime Floridamarkets,” says Bryan Belk, senior directorin Franklin Street’s Atlanta office. “Nowthat returns in those markets have com-pressed, we are seeing more large inves-tors willing to stretch out to markets suchas Nashville, Huntsville or Jacksonville toget returns they promised to their inves-tors because competition and lack of sup-ply in primary markets is so great.”Steve Grimes, CEO of Oak Brook,IL-based Retail Properties of America, aself-managed REIT focused on the acqui-sition, development and management ofstrategically located real estate assets andone of the largest owners and operators ofshopping centers in the US, sees investorsshifting from new acquisition returns toproperties with long-term development orredevelopment/densification opportuni-ties, especially in urban areas.

“From a return-on-cost perspective,development and redevelopment returnsare strong in contrast to new-acquisitionreturns,” Grimes says, “and with the con-tinued lack of new supply, especially in theclass A retail centers, redevelopmentopportunities and secondary marketshave been driving better returns-on-investment as demand continues to out-weigh supply.”The office sector has seen a definiteshift in the past year, according to MartinCaverly, chief investment officer at LosAngeles-based Resource Real Estate, anational real estate firm specializing inopportunistic and value-added investingin and financing of commercial realestate. He is starting to see commercialoffice space migrate out of the big fivegateway markets—Los Angeles, SanFrancisco, Washington DC, New York,Boston—into surrounding areas, such asBrooklyn, West Side L.A., Downtown L.A.or Orange County.

“Like most asset classes today, it’s asearch for yield. In every cycle, core cen-tral business districts in most marketsrecover first and then demand moves outto secondary markets,” Caverly says. “Twoyears ago, investors wouldn’t touchPhoenix. Now, it’s gaining traction.Unfortunately, people forget that second-ary markets trade at higher yields to makeup for the fact that they are more volatile,so your chances of losing occupancy in adownturn are much greater.”

CLEAR CHALLENGES AHEAD

Nobody has a Pollyanna attitude about
commercial real estate investing in 2016.
Clearly, challenges lie ahead. Kurt
Westfield, managing director of WC Cos.,
a group of real estate, investment, property management and financing companies based in Tampa, FL, expects the biggest challenges to be finding quality
inventory and competing with liquid and
institutional investors.

“On the heels of Blackstone, there arestill a number of smaller, albeit capital-heavy, institutional players absorbingunits,” Westfield says. “Additionally, withinterest rates still low, more investors areable to secure mortgage instruments withlow debt thresholds. I don’t foresee anymajor barriers to entry or new challengesin 2016 that haven’t been witnessed orovercome in 2015.”Rising interest rates are an ongoingconcern and a frequent topic of discus-sion. That said, investors have been listen-ing to failed predictions of rising interestrates for the past five years. Interest ratesare bound to rise at some point, though,and Sykes says that would reduce availableleverage and investor returns, adding vol-atility to the already razor-thin pricesgroups are paying for multifamily assets.One thing is certain: REITs in particu-lar can no longer rely on record-low inter-est rates to push cap rate compression andvalue bumps. The focus, says Grimes,needs to be on improving organic growthto drive NAV. But there are still other con-cerns, like finding good deals, even value-added deals. These are fewer and fartherbetween in a mostly recovered market.

“The biggest challenge for investors in
2016 will be finding a suitable product
that meets yield and return expectations
without taking too much risk,” says
Caverly. “Supply is certainly going to start
becoming an underwriting issue in some
markets as well. Rate uncertainty may create some short-term wobbles, but, over
the longer term, historically higher rates
have been good for real estate.”

WHAT TO BET AND BANK ON

With all of these factors in mind, what are
the safest bets? What can investors truly
bank on? What sectors should be
approached with caution or avoided altogether in certain markets? Franklin
Street’s Belk recommends taking a “back
to basics” approach that entails buying
well-located real estate that can survive
tenant turnover.

“For desired locations we are seeingcontinued rent escalations that landlordsare getting in the 20% to 30% range,” saysBelk. “A lot of those locations signed five-year leases back when the market wassofter and landlords have continued to beable to successfully raise rents, as thoseleases have rolled for renewal becausethere is more tenant competition forspaces in this market.”Grimes stresses that retail has beenconsidered ripe for capital investment.That’s because investors, from a yieldperspective, are having a tougher time

Common sense would
dictate a slowdown in

2016, but I don’t see a
meaningful slowdown,
since equity raises are
at an all-time high.”